The latest economic activity shows clear signs of improvement ahead. Consequently, the demand for land, especially for construction of commercial and residential properties, will be solid and rising throughout 2018 and into 2019. The demand for agricultural land is more difficult to predict.
First, let’s take a look at the economic backdrop. Gross Domestic Product (GDP) grew at a three percent annualized rate in the third quarter. That is quite remarkable in light of the temporary standstill in activity in hurricane-impacted regions. The big contributors were the solid rise in business spending on equipment, which burst higher by 8.6 percent, and improvements in net exports (exports rose 2.3 percent and imports fell 0.8 percent). Software spending rose spectacularly by 24 percent. Such demand is undoubtedly being driven by the new world of digital information. Land in the middle of nowhere could soon be sought after as more data centers need to be built. Information from every Uber ride and Amazon sale are being stored digitally. Every piece of information from GPS units and the future self-driving mapping of automobiles will also need to be stored.
Consumer spending is the biggest share of the nation’s economy and grew in the latest quarter at a decent pace of 2.4 percent. This is a tad short of the near three percent growth in consumer purchases in the past three years but still implies enough power to avoid any recession.
Third-quarter GDP growth was also partly boosted by inventory accumulation of goods. Sometimes this is a good thing, as companies are ramping up production in anticipation of stronger demand ahead. However, it also hints at a potential economic slowdown if the large inventory buildup requires cutting back on future production.
Government spending has been neutral, neither adding nor subtracting to GDP growth. Federal government spending rose one percent while state and local government spending fell one percent during the latest quarter.
The missing piston to the engine of economic growth is currently real estate construction. Private commercial building construction spending fell by 5.2 percent and residential real estate spending from new home construction and home sales activity declined by six percent. Commercial building vacancy rates have been steadily falling across all property types over the past several years, and that will continue to be the case as new construction is just not coming around. As to the residential market, it is undergoing some of the tightest inventory conditions ever seen, with the quickening pace of homes selling right after coming onto the market and with multiple bids not uncommon in the lower price brackets. Home prices have been moving consistently above workers’ wage growth for the past five years. However, unlike the housing bubble days of 2005 with easy subprime credit, today’s market conditions reflect tight mortgage availability. The market has the feel of a “bubble” because of insufficient housing inventory. For the past decade, the construction of new single-family homes has been far below the 50-year historical average. Soft construction activity assures continuing tight inventory conditions, and there is certainly no oversupply in either the commercial or residential real estate industry.
I am forecasting that housing starts will rise from 1.18 million housing starts in 2017 to 1.30 million in 2018. This growth will still be insufficient to fully satisfy rising housing demand. The long-term historical average has been for 1.5 million new homes constructed each year in the U.S. The low inventory conditions of near four months’ supply implies continuing rising in home values in most parts of the country. Homebuilders have indicated that, on average, it takes only 2.9 months to find a buyer of their spec homes. It is a fast-moving market, considering that just five years ago it took over an average of eight months.
Homebuilders need to ramp up construction. However, they have been hampered by skilled worker shortages in the industry and from the difficulty of obtaining construction loans by smaller builders. As to the latter, there could be more loans coming down the pike, as some of the financial regulations that arose from the Dodd-Frank legislation are likely to be loosened somewhat for small-sized community banks. In regards to construction workers, it is going to take some time to recruit to fully meet the requirements. Trade schools are just not seeing enough interested people entering the industry, especially among the younger cohorts. Moreover, the hurricanes that devastated the Houston region and Florida will require a large number of construction workers just to replace the damaged and demolished homes. An estimated 50,000 homes were damaged in Houston alone and around 70,000 in Florida. This work is not adding to the housing stock, but an attempt to maintain current levels. That means that demand for land development in other parts of the country will see delays because of the acute worker shortage.
Last year’s Land Markets Survey conducted by the REALTORS® Land Institute and the NAR Research Department indicated that half of the members were involved in recreational and residential land transactions, and the average increase in value of those sales was two percent. Given that home prices have risen five percent in 2016 and another five percent in 2017, the prospect for land price increases should have seen an increase of that magnitude. For those involved in timberland sales, the rising lumber prices (partly attributed to global economic expansion and from wildfires in the Western U.S. states and in Canada) will permit a higher price sale in the upcoming year. Those specializing in agricultural land will face tougher conditions. The crop prices that farmers have been receiving over the past three years have been in a rut with prices now more than 20 percent lower compared to the boom times in 2012. Therefore, the yield from agricultural land will be lower.
Risks to the Economy
There is very little risk of an impending economic recession. Job openings are at a multi-year high and the number of people filing for unemployment insurance claims remains at historic lows. Such conditions imply that job growth of around two million is nearly assured in 2018. However, one area of concern relates to international trade war. Experience shows that job cutting occurs when both imports and exports decline measurably, as happened during the recent Great Recession and at the turn of the century. Also of course, many economists blame the 1930s Great Depression for tariff hikes across most countries around the globe at that time. President Donald Trump’s rhetoric on trade has been “tough,” including the idea of ending NAFTA and a trade war with China. Protection of intellectual property rights must be assured, and fairness in trade needs to be constantly examined. However, a unilateral increase in U.S. tariffs will certainly invite retaliation. Such actions, depending upon the magnitude of the tariffs, could easily wreak havoc on global supply-chain production and send the economies of the world on a downward path. Agricultural exports would be particularly hard hit, thereby hurting agricultural land prices. This development, therefore, requires alert watchfulness.
A second risk is related to the tax reform without proper safeguards for real estate. If the mortgage interest deduction is no longer attractive and/or property tax deductions are no longer permitted, then the demand in home purchases and residential developable land will decline measurably. Changes to, or even a removal of, the all-important 1031 like-kind exchanges could also greatly hurt land values.
However, assuming there are no shocks to the system from international trade and that tax reform is pursued properly without hurting real estate, then investments in land will be on the rise making now a good time to be in the land sales business.
This article originally appeared in the 2018 Winter Terra Firma Magazine, the official publication of the REALTORS® Land Institute.
About the Author: Dr. Lawrence Yun is chief economist and senior vice president of Research at the National Association of REALTORS®. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1.1 million REALTOR® members.